Question

. AEC Company issues common stock that is expected to pay a dividend over the next year of $2 at a stock price of $20 per share today. If its WACC is 12% and the company is financed by 30% debt and 70% equity, calculate the expected growth rate of dividend (=g), given the cost of debt is 5% and tax rate is 0%?
A) 5.0%

B) 7.0%

C) 9.0%

D) 12.0%

Answer 1

Answer:

A) 5.0%

Explanation:

AEC Company expects to pay a dividend over the next year of $2 at a stock price of $20 per share, thus the dividend rate over next year = $2/ $20 = 10%

The WACC is 12%, the company is financed by 30% debt and 70% equity, and the cost of debt is 5%;

WACC 12%= 30% x cost of debt 5% + 70% x cost of equity  

->Cost of equity = (12% -30%*5%)/70% = 15%

Thus expected growth rate of dividend = Cost of equity 15% - dividend rate over next year 10% = 5%